The effect of an indirect tax on the demand for, and supply of, a product
Indirect tax placed on selling price, shifts curve vertically upwards by the amount
Less product will be supplied at every price
2 types of indirect taxes
1. Specific Tax
A fixed amount of tax (1$ per unit)
The tax doesn’t affect the ‘slope’ of the curve
2. Percentage Tax
Tax is the percentage of the selling price
Higher the price, more the tax
‘Slope’ is altered
Indirect tax’s effect on producers and consumers
When an indirect tax is imposed, at the new price, there is a surplus so the market self-adjusts the equilibrium
The consumers see a rise in the price they have to pay, from the old equilibrium to the new equilibrium, and this amount times the quantity is the tax burden of the consumers. (Note that the rise of the prices the consumers pay are not equal to the quantity of the tax itself)
The government’s total tax revenue, minus the revenue that the consumers are responsible to pay equals the producers tax burden
Government’s total tax revenue is price of tax multiplied by the quantity of the new equilibrium point
The effect of a subsidy on the demand for, and supply of a product
A subsidy is the amount of money paid by the government to a firm, per unit of output
A government would give a subsidy because…
1. To lower price of essential goods, promoting more consumption
2. To prevent unemployment by guaranteeing the supply of products that they consider necessity to the economy
3. To enable producers to compete with overseas trade, protecting home industry
When an subsidy is imposed, the equilibrium shifts right along the demand curve
The total amount of government subsidy is the quantity of subsidy (represented by vertical shift) multiplied by the quantity bought at the new equilibrium price
The quantity of the subsidy does not always equal the price change consumer’s experience
You can’t really tell just by the subsidy that the total expenditure of the consumer decreased, because you are buying more at a lower price.
Depends on the relative saving and extra expenditure
Evaluation of government
Opportunity cost of subsidy
Does the subsidy do what is should, such as making firms more efficient, and allowing local firms to compete with foreign firms
A subsidy will almost always result in a taxation in other products, who is paying the taxes?
Damage of other firms by unfair subsidies on specific firms, especially to foreign firms
Many high-income country farmers are able to sell products beneath their cost of production due to the government’s huge subsidies, which completely wipes out the ability of developing-country farmers, as they receive no subsidy when competing with them.
Price controls
The free market does not always lead to the best outcome
Therefore, the government needs to intervene in order to achieve a better outcome
By setting maximum and minimum prices
Maximum (low) price controls (price ceilings, which ironically are more like floors)
Government sets a maximum price below equilibrium price
Prevents producers from raising price above it
Protect consumers, imposed on necessities due to their relatively less change of quantity demanded compared to change of price
Especially useful when there’s a product shortage (product is necessity), set maximum price to ensure those with low income can still purchase necessities
However, due to the lowered price, the quantity demand exceeds quantity supplied, creating a surplus
The consumption of the product has actually fallen, as less are supplied due to the lowered price
The excess in demand creates many troubles such as black markets or discrimination of consumers by producers.
The government now needs to eliminate the shortage
The government can do two of the following: shift the demand curve left, or the supply curve right
If you shift the demand curve left, you would be decreasing your total consumption, which goes against the whole point of imposing maximum prices
You can shift the supply curve right by…
1. Providing subsidies to promote more production
2. Producing the good from the government, thus increasing the total supply
3. Releasing the previously stored product. (Product cannot be perishable)
It seems like the problem is solved, but this shift of supply curve means that the government incurs a cost, especially for the case of subsidies
A subsidy for this particular market means it has to reduce the expenditure of other areas, opportunity cost
Minimum (high) price controls (price floors)
Attempt to raise incomes of producers of goods that they consider important.
Usually helped because prone to large fluctuations and foreign competition
Protect workers by setting a minimum wage
With government intervention, there is a surplus. If nothing is done, consumption will actually decrease
Surplus will lead to suppliers trying to illegal sell products at a lower price
Government intervenes normally by buying up the surplus products at the minimum price, therefore increasing demand.
The government is able to store the surplus, destroy or sell it abroad.
Storing can be expensive and wasteful
Selling abroad can harm other country’s domestic industries
Again, the opportunity cost of buying and storing surplus will result in the reduction of others
Two other ways minimum price can be maintained
Setting quotas, or by increasing demand for the product by advertising
Notes from Mr.Izzy’s lecture
Most of the taxes (except income taxes) affect the supply graph because at the end it is those suppliers who turn in the tax into the government
The price increase does not equal the tax, it’s split between the buyer and seller
Elasticity of the curves change the tax split between the consumers and producers
Inelastic demand curve results in a bigger portion of the tax paid by consumers, and vice versa
Subsidy: per unit payment that government provides
Total revenue of the suppliers is not equivalent to the total revenue of the consumers. It’s Q2P2 + the total tax revenue the government imposed. (tax amount times quantity produced)
Summary Because the government needs money for the good of the economy and society (hopefully), they need to impose taxes on some products. To keep the economy running smoothly, they will sometimes also impose subsidies on products. Both actions, taxation and subsidization, creates burden for both consumers and producers, as they have to either pay more or less for the same product. The question of who bears a bigger burden depends on the elasticity of the product. Due to the nature of the self-adjusting market, sometimes, the equilibrium price set by the market isn’t the best, and therefore requires the government to intervene to adjust the equilibrium point to the ‘right’ or ‘efficient’ point. They could do this by setting a price ceiling or a price floor, but this brings many consequences such as surpluses and shortages. To solve these problems, the government has to take additional steps such as buying the surpluses, or storing them. All of these cost additional fees, which has to be collected from taxes, which will result in the decrease of expenditure of the government in different areas such as education, opportunity cost is vital in evaluating the government’s intervention.
Questions
1. To what extent should a government be allowed to intervene in a market?
2. What other methods can the government use to ‘fix’ the equilibrium price?
3. Is it ethical for high-income government to still offer domestic firms subsidies just to out-compete their competitors in foreign trade? Or should there be a regulation promoting the growth of developing country’s economy?
4. How does the price elasticity of a product affect the burden distribution to consumers and producers?
5. Can subsidy actually result in an increase in expenditure for the consumers?
Found Awesomeness
Because when we were doing this InNo, Mr. Israel was away, we had to solely rely on the textbook to understand the material. However, without Mr. Israel's insightful lecture, I had some confusions of the concept of taxation and subsidies illustrated through a demand and supply curve, especially the boxes that goes with the graph. Therefore, I went on youtube and searched for lectures that will enhance my understanding, and this video helped me a lot. I also realized that his channel features many useful video dealing with economic concepts that we are learning. Everytime I'm unsure of a concept, I would most likely refer back to this page.
1. What is the difference between a specific and a percentage tax? (5pt)
2. What is an indirect tax? What is a price ceiling? What is a price floor? (10pt)
3. Illustrate a percentage tax on a graph (5pt)
4. How does the elasticity of the product affect the burden tax revenue shared by the consumers and producers? (10pt)
5. Is the tax revenue same when the government imposed a percentage tax? Is the burden shared by the consumer and producers same on every point when a percentage tax is imposed? (20pt)
6. In what cases do the consumers have to bear all the burden of the taxes imposed by the government? (5pt)
7. In what cases do the producers have to bear all the burden of the taxes imposed by the government? (5pt)
8. List the problems that a government intervention (for both price ceiling and floor) will cause, and the solutions for those problems. (20pt)
9. Illustrate a quota on the supply and demand graph (20pt)
This is a test that assesses the participant on the materials presented in chapter 5. The questions vary from drawing graphs, illustrating interventions, describing effects and defining key terms. By answering these questions correctly, the participant would have demonstrated their knowledge of chapter 5.
- Indirect tax placed on selling price, shifts curve vertically upwards by the amount
- Less product will be supplied at every price
2 types of indirect taxes- Tax is the percentage of the selling price
- Higher the price, more the tax
- ‘Slope’ is altered
Indirect tax’s effect on producers and consumersThe effect of a subsidy on the demand for, and supply of a product
Evaluation of government
Price controls
Maximum (low) price controls (price ceilings, which ironically are more like floors)
Minimum (high) price controls (price floors)
Notes from Mr.Izzy’s lecture
Summary
Because the government needs money for the good of the economy and society (hopefully), they need to impose taxes on some products. To keep the economy running smoothly, they will sometimes also impose subsidies on products. Both actions, taxation and subsidization, creates burden for both consumers and producers, as they have to either pay more or less for the same product. The question of who bears a bigger burden depends on the elasticity of the product. Due to the nature of the self-adjusting market, sometimes, the equilibrium price set by the market isn’t the best, and therefore requires the government to intervene to adjust the equilibrium point to the ‘right’ or ‘efficient’ point. They could do this by setting a price ceiling or a price floor, but this brings many consequences such as surpluses and shortages. To solve these problems, the government has to take additional steps such as buying the surpluses, or storing them. All of these cost additional fees, which has to be collected from taxes, which will result in the decrease of expenditure of the government in different areas such as education, opportunity cost is vital in evaluating the government’s intervention.
Questions
Found Awesomeness
Because when we were doing this InNo, Mr. Israel was away, we had to solely rely on the textbook to understand the material. However, without Mr. Israel's insightful lecture, I had some confusions of the concept of taxation and subsidies illustrated through a demand and supply curve, especially the boxes that goes with the graph. Therefore, I went on youtube and searched for lectures that will enhance my understanding, and this video helped me a lot. I also realized that his channel features many useful video dealing with economic concepts that we are learning. Everytime I'm unsure of a concept, I would most likely refer back to this page.
Citations: Indirect Taxation N.p., 22 Aug. 2008. Web. 24 Nov. 2014. <https://www.youtube.com/watch?v=t9N4La0-k9c&spfreload=1.>
Original Awesomeness
Chris’s Chapter 5 Test
This is a test that assesses the participant on the materials presented in chapter 5. The questions vary from drawing graphs, illustrating interventions, describing effects and defining key terms. By answering these questions correctly, the participant would have demonstrated their knowledge of chapter 5.